Finance Career: Q&A for Physics PhD Seeking Advice | TwoFishQuant

[chill_factor]

As you stated earlier, the statistics above will likely only include official residents, and hence would not take into account the large numbers of "migrant workers" i.e. those who originally come from rural areas but who migrate to urban areas for employment. Given the hukou system of residency classification, these people are unable to obtain title to real estate in the urban areas and are often denied many social services such as education, etc.

http://en.wikipedia.org/wiki/Hukou_system#Effect_on_rural_workers

You can buy real estate anywhere you want, nothing to do with the Hukou system.

 

[intelwanderer]

You can buy real estate anywhere you want, nothing to do with the Hukou system.

For a rural peasant in Guizhou province who wants to move to the city, what good would that do? You could never afford the real estate, and even if you could, you would still need the Hukou in order to get the services that you might be moving to the city for(education for your kids)?

This is getting off track. Beware the mods, people.

 

[twofish-quant]

He said that they didn't care about the political, social or emotional issues.

Different places on Wall Street have different cultures. The place that I work at cares a lot about political, social, emotional, and ethical issues.

The purpose of a bank is to make money, not prop up the state and "you wouldn't want it any other way, or you'd have moved to China". I thought about it for about 5 seconds, then I realized he was right.

Ummmm... Make money from whom?

This is pretty important because when I give my money to a bank, I sort of would like to get it back, and the easiest way for the person I'm giving it to to make money is to stuff that money in his pocket and disappear.

As far as "moving to China"... Well...

 

[twofish-quant]

Given the hukou system of residency classification, these people are unable to obtain title to real estate in the urban areas and are often denied many social services such as education, etc.

The first part is false, a migrant worker buy whatever land or real estate that they want, and if you have the money to buy real estate, you probably go through the bureaucracy to get your residency formally changed.

The second part is a big problem having to do with economic reality. If you could wave a magic wand and give rural residents access to free education, pensions, and health care, people would. The trouble is that there is this matter of paying for this, and a lot of tension between different groups. For example, the central government is trying to enforce a rule that says that migrants can get free education. The trouble is that then you have to figure out how to pay teachers, and so you end up with school hinting that they would like gifts.

Finally, there are situations in which someone do *not* want to change residency even if they wanted to. If you have rural residency, then you are legally entitled to farm land. So if you lose your job in the city, you can theoretical return and farm some land. The trouble with this is that increasing number of migrants have actually never farmed anything, so this is theoretical for a lot of people.

It's a tough problem, and I think the government is handling it as well as can be expected. The difficulty is not rights but services. Rural migrants have to pay "market rates" for health care and education whereas people with residency cards get those services from the government for "free".

This is why the government wants scientists. No economic growth = hard decisions. Economic growth from science and technology = you can provide free services to everyone.

Furthermore, I would be interested in knowing what the home or land ownership rates for those living in rural China.

In rural China, you are legally entitled to housing but the house is owned by the state. Rural residents don't have title to their homes (i.e. they can't sell the house), but they don't pay rent either.

Farmland is also collectively owned, but you have the legal right to a piece of farmland that you can farm and anything you make out of the farmland assigned to you is yours.

The problem comes in when the village government tries to sell a piece of land to make something like apartments. Personally, I think that the ownership system is *good* because if plots were individually owned then what would happen is that the village government would force an individual farmer to sell. Because the land is owned by the entire village, when the government tries to sell the land and pocket the money, then everyone gets mad. However, there is a another side to the picture. If the government doesn't profit from land sales then how does it pay for the schools? (If fact, the central government has taken over school funding so increasingly protests are over environmental issues.)

One other thing is that the farmers with hukou issues are a different set of farmers than the ones that protest over land sales. The people that migrate to the big cities are from places where it's pointless to protest over the money from land sales, because the land is worthless. Places where farmers protest over land sales are places where people aren't moving to the cities. Also, a poor farmer gets to the city, they generally live in a places provides by "apartment farmers." What happens is that you are a farmer in suburban Beijing and you have an allocation right to farm some land. At some point you realize that you can make more money by building some shacks, and you do it even though legally you are suppposed to use the land for farming.

I ask this due to reports about land seizures in rural areas to make way for industrial development, and violent protests that result from this.

Yup. It's an issue but people are dealing with it as rationally as they can. People have suggested some solutions and things are progressing, but it's a moderately hard problem, and a lot of the easy, obvious solutions have problems.

Also, none of this is likely to cause the government to be overthrown. Most of these protests are about money, and if you overthrow the government then everyone loses.

 

[chill_factor]

Different places on Wall Street have different cultures. The place that I work at cares a lot about political, social, emotional, and ethical issues.

What is the difference between a hedge fund and an investment bank? What type of entity do you work for?

 

[Moppy]

What type of entity do you work for?

You're not the first person to ask him that.

 

[twofish-quant]

I'm more open about who I work for over private e-mail. One thing I find extremely annoying about the financial industry is that there are a lot of policies and in some cases laws that keep people from being too open. One thing about banking culture is that it's very "why do you need to know this?" After all, would you really trust your money to someone that gives your checking account number to anyone who asks?

What is the difference between a hedge fund and an investment bank? What type of entity do you work for?

The cultural differences are that I was talking about is not so much between hedge funds and investment banks, but rather between different groups and different people. It's a good thing to have a diversity of opinions.

Also hedge fund takes money from rich investors and invests them. The thing about rich investors is that they are allowed to invest in things that "ordinary people" aren't allowed to. However, the reason for this is that rich investors have the "license to be stupid with their money." If you have someone ordinary loses $100,000 in an investment, then this will be a bad thing, and if you have millions of people lose $100,000, they will demand that the government do something about it.

So the government has put in a lot of rules that "protect people from themselves" and banks and mutual funds that take money from ordinary people have to operate under strict rules. From the point of Ph.D. hiring "strict rules=boring math." Hedge funds can take money from rich people and do whatever they wanted with it as long as it isn't fraudulent. The catch is that if a rich millionaire loses $100,000 then we can just laugh at him.

You can think of an investment bank as a "wholesale financial shopping mall". Your typical investment offers a lot of services. If you want to sell real estate, you go to a real estate agent. If you want to sell a company, you go to a investment bank where they have people who are "company sales agents." Also, if you want to sell $10,000 in stocks you go to a retail broker or a mutual fund. However, if the retail broker or mutual fund wants to sell $1 million in stock, then they go to the investment bank.

 

[Moppy]

I'm more open about who I work for over private e-mail. One thing I find extremely annoying about the financial industry is that there are a lot of policies and in some cases laws that keep people from being too open. One thing about banking culture is that it's very "why do you need to know this?" After all, would you really trust your money to someone that gives your checking account number to anyone who asks?

No one is asking you for trade secrets like your position on a stock or your strategy in case Greece exits the Euro. They're asking what you do. I don't understand how client details even come into this, unless you're a wealth manager or something.

My personal opinion is that you are engaged in financial research of some kind in a think tank (private or government) and not directly involved in the business of the market. I think this because you are too much into philisophy and morality to be a let loose as a consultant on businesses and individuals who make enough money to make ethical discussions non-trivial. This is not to say they have none, but it would not be your job to fuss about it. You don't have the belief in your own invincibility that traders have. Every trader I know who is not married has little savings and sees regulation as a barrier to be circumvented. You have some gaps in your knowledge of how the markets work e.g. not knowing what the Fed does etc.

So a researcher. This is not a criticism. This is analysis. I am open to being corrected.

 

[twofish-quant]

No one is asking you for trade secrets like your position on a stock or your strategy in case Greece exits the Euro. They're asking what you do. I don't understand how client details even come into this, unless you're a wealth manager or something.

Well then you haven't taken legal and compliance training... One reason that people in finance are tight lipped is that by finding out what people do, you can figure out some things that not supposed to leak out. For example, if you know that financial institution X hired Y people to calculate Z, then you can probably figure out a lot about that strategy.

My personal opinion is that you are engaged in financial research of some kind in a think tank (private or government) and not directly involved in the business of the market.

Well you are wrong.

I think this because you are too much into philisophy and morality to be a let loose as a consultant on businesses and individuals who make enough money to make ethical discussions non-trivial.

Different places have different standards. I prefer to work somewhere with high moral and ethical standards. Now ethics is very non-trivial. It's sometimes very difficult to figure out what the *right* thing to do is, but that means that you should think about these things more rather than less.

You don't have the belief in your own invincibility that traders have. Every trader I know who is not married has little savings and sees regulation as a barrier to be circumvented.

And any trader that thinks themselves to be invinciable will get very quickly fired where I work. Good thing too.

You have some gaps in your knowledge of how the markets work e.g. not knowing what the Fed does etc.

One of the major functions of the Fed is to serve as the chief regulator for US-based financial holding companies under the Graham-Leach-Billey Act. This is actually an interesting trick question. Who is the major regulator for US investment banks? Most people would incorrectly guess the SEC.

So a researcher. This is not a criticism. This is analysis. I am open to being corrected.

Well consider yourself corrected.

Also, if you really wanted to know what I do, you could try asking? I may or may not tell you, but it's worth a shot.

 

[Moppy]

I checked and you're right, the Fed does regulate. I had no idea they did. The guys I deal with are always complaining about two US regulators (US OCC and New York State's one, is it the DFS?) and the FSA (UK) being in the UK. I don't know why the Fed doesn't cover them, or perhaps it does in an way that they don't care about. The big talk right now is the New York State one because the OCC does less than nothing ([STRIKE]i.e. it's bent and you can pay it to look the other way[/STRIKE] they know people aren't in compliance, but do nothing).

No-one is asking you for trade secrets. You could say "I am working on automated trading systems" without giving anything away.

I'm really having trouble matching your experience of traders with mine. I know the US says British regulation is "lapse" but they're still bankers.

Edit: I don't for one minute believe saying you can talk about in private email and not publically makes a difference. Nothing in email is private.

 

[twofish-quant]

I checked and you're right, the Fed does regulate. I had no idea they did. The guys I deal with are always complaining about two US regulators (US OCC and New York State's one, is it the DFS?) and the FSA (UK) being in the UK. I don't know why the Fed doesn't cover them, or perhaps it does in an way that they don't care about.

DFS was recently created by New York state. In the case of a federally chartered bank, federal laws preempt state ones, so the state regulators have almost no role. OCC is important for commercial banking operations but they don't have much of a role in investment banking.

If they are a UK bank which is not a US primary broker-dealer, then it's likely that the Fed doesn't take an active role in regulation and relies on the FSA to do oversight. Also, state regulators can't really regulate Federally chartered banks, but non-US banks need state permission to operate so state regulators do regulate non-US banks.

The big talk right now is the New York State one because the OCC does less than nothing ([STRIKE]i.e. it's bent and you can pay it to look the other way[/STRIKE] they know people aren't in compliance, but do nothing).

Whereas in NY you have a governor that wants a lot of good press.

One reason the Fed has a lot more teeth than OCC has to do with funding. OCC is funded from banking fees which means that it doesn't have either the money or the interest to enforce regulations, and if it tries, it is looking at a long and expensive court fight. The Fed on the other hand can just stop loaning you money if it doesn't like what what are doing, and if you are a primary dealer, that will kill you.

No-one is asking you for trade secrets. You could say "I am working on automated trading systems" without giving anything away.

Ummm... I know of someone that got into trouble by saying something they thought was innocent. I'm going to err on the side of saying nothing publicly.

In fact, the *only* reason that I post anything at all on this is because when I went through the pain and agony of getting work, I was frustrated by the lack of good information, and I made myself the promise that if I got in, that I'd make life easier for other people.

I'm really having trouble matching your experience of traders with mine. I know the US says British regulation is "lapse" but they're still bankers.

We just know different people then. One good thing about Wall Street is that there are so many different firms with different cultures, and to a large extent that is a good thing, as long as no one blows up the world.

Edit: I don't for one minute believe saying you can talk about in private email and not publically makes a difference. Nothing in email is private.

Something that the compliance people tell you is that everything that say over a corporate e-mail address is recorded and monitored by the regulators, and if they really want to, it's not hard to subpoena stuff over your personal e-mail.

But that's not the point. The point is that if I say something over private e-mail, I can keep track of and control who I talk to, whereas I can't do that over a public forum. I can make reasonably sure that the person I talk to won't abuse any information that I give them, and if they do I know who did it.

 

[Mr.Watson]

How hard is it actually to break into finance after theoretical physics phd? I am still undergrad and I'm hoping to get into academia after phd (and postdocs off course), but I know that there is huge competition for faculty openings and I am sometimes pretty worried that I won't find any job where I can use my education. Lately I have being reasonably interested about career and finance as a second choude.

Offcourse things change, and everything might be different when I will get my phd, but just out of curiosity: How hard is it right now to break into finance as a physics phd? And is there regional differences, like is it easier in NYC than London as a physicist? And is it easier to break into finance with physics or mathematics background?

And yeah, I know that things might be entirely different when I have gone trough grad school, but just out of curiosity I would like to know how things are right now or how they have been in previous couple of years. I remember that twofish-quant once wrote that He doesn't know any physicist who wouldn't be able to get some job from finance. Is the job outlook really so good?

 

[Vampyr]

How hard is it actually to break into finance after theoretical physics phd? I am still undergrad and I'm hoping to get into academia after phd (and postdocs off course), but I know that there is huge competition for faculty openings and I am sometimes pretty worried that I won't find any job where I can use my education. Lately I have being reasonably interested about career and finance as a second choude.

Offcourse things change, and everything might be different when I will get my phd, but just out of curiosity: How hard is it right now to break into finance as a physics phd? And is there regional differences, like is it easier in NYC than London as a physicist? And is it easier to break into finance with physics or mathematics background?

And yeah, I know that things might be entirely different when I have gone trough grad school, but just out of curiosity I would like to know how things are right now or how they have been in previous couple of years. I remember that twofish-quant once wrote that He doesn't know any physicist who wouldn't be able to get some job from finance. Is the job outlook really so good?

What do you mean by "finance", because that describes a lot of different careers. Most finance careers do not involve highly mathematical/programming type of work. Anyone with demonstrable analytical skills (eg physicist) will be able to get a job somewhere in finance, but this is not necessarily the same as quantitative finance.

 

[Mr.Watson]

What do you mean by "finance", because that describes a lot of different careers. Most finance careers do not involve highly mathematical/programming type of work. Anyone with demonstrable analytical skills (eg physicist) will be able to get a job somewhere in finance, but this is not necessarily the same as quantitative finance.

What I meant was a career that at least somehow involves skills that physicist have. So my question was basicly how hard is it to break into quantitative finance with physics degree.

 

[SolomonX]

I am probably being naive but I don't understand why students studying physics (or any science for that matter) would choose a field as socially useless as finance. I once had a "superior" tell me he laid off an entire factory (500+) of people to save a few percentage points on a balance sheet for the owner. The man was worked in corporate finance so I believe that is different from the kind of work two-fish quant does, i.e. high finance, the kind many on this forum seem to aspire to.

Instead of channeling your prodigious mental capabilities towards financial work, why not try and develop something useful for the economy and for society? A sure road to wealth is to create productive goods and services that people desire. I know this is easier said than done and indeed, you may fail. However, failure is a risk in any enterprise. I'd rather fail at establishing a business or shooting for tenure than failing at being some financial whiz. This is the way I felt after earning my bachelor's degree in economics.

I commend two-fish's suggestion that the OP learn the humanities. Too often, people forget that their decision have a real impact on others (e.g., shutting down factories). Reading a bit of philosophy, literature and history helps to gain a broader perspective on our world and our role in it.

 

[mayonaise]

I am probably being naive but I don't understand why students studying physics (or any science for that matter) would choose a field as socially useless as finance.

Two reasons I can think of. First, it is socially useful for me or any other physics grad to not perish in the tenure pursuit. The other is finance actually is useful for something for some people, otherwise you don't get paid.

Instead of channeling your prodigious mental capabilities towards financial work, why not try and develop something useful for the economy and for society? A sure road to wealth is to create productive goods and services that people desire.

Unfortunately, research papers usually are not what people desire. Creating goods and services is not a sure road to wealth, otherwise the 500+ workers who were creating goods would be rich instead of jobless. Or maybe the goods they produced were not desired, then your superior did the right thing and (corporate) finance *is* useful.

 

[NegativeDept]

First, it is socially useful for me or any other physics grad to not perish in the tenure pursuit.

That's the elephant in the room. Many (probably most) of the very smart recent PhDs from my program can't find work as research physicists. The rest of them are temporary adjuncts or postdocs whose meager pay isn't enough to amortize their student loans.

And as mayonaise also mentioned, competent finance workers can produce social value. If a bunch of physics nerds can figure out how to not blow up the financial system - or at least make the crashes smaller and more manageable - that would be very useful. (Whether it's more useful than e.g. biophysics research or solar energy is a tougher question.)

 

[intelwanderer]

Would it be possible for them to find a research position that is like engineering or applied physics? Or in something that is technical, but not related to their dissertation(different subfield of physics or applied physics/matsci/engineering)?

I have a hard time believing someone with a experimental physics Phd(theorists might have it harder, I admit, but I'd imagine they could teach themselves what they don't know) couldn't do something like materials science or semiconductor research. I'd imagine that they could learn what they don't know quickly.

But I do agree. Finance is important. Can you imagine what it would have been like if the economy completely crashed? I just don't want finance to be the ONLY option for physics Phd's...

And in all honesty, I'd rather have a physicist in charge of finance than an MBA/sales guy. Maybe that's not a wise idea(can a physicist sell and have people skills), but I'm admitting my bias. Maybe the thing is that they shouldn't BE PREVENTED from doing something like that because they are scientists, but not automatically get it over a lawyer/sales type.

 

[SolomonX]

Two reasons I can think of. First, it is socially useful for me or any other physics grad to not perish in the tenure pursuit.

Why?

The other is finance actually is useful for something for some people, otherwise you don't get paid.

I'm not disputing the use of finance altogether just the extent to which the industry has grow. A good read about bringing in physicist to Wall Street is Michael Lewis' book Liar's Poker.

Unfortunately, research papers usually are not what people desire. Creating goods and services is not a sure road to wealth, otherwise the 500+ workers who were creating goods would be rich instead of jobless. Or maybe the goods they produced were not desired, then your superior did the right thing and (corporate) finance *is* useful.

Not to be mean, but if you don't think bringing goods and services into the economy is a road to wealth then you have no business in business. I'm not sure what goods were produced in the factory but reducing a nation's industrial base is ruinous in the long run. Many innovations come about by laborers in factories inventing more efficient methods of production. I remember an anecdote like this in the Wealth of Nations.

 

[SolomonX]

But I do agree. Finance is important. Can you imagine what it would have been like if the economy completely crashed? I just don't want finance to be the ONLY option for physics Phd's...

And in all honesty, I'd rather have a physicist in charge of finance than an MBA/sales guy. Maybe that's not a wise idea(can a physicist sell and have people skills), but I'm admitting my bias. Maybe the thing is that they shouldn't BE PREVENTED from doing something like that because they are scientists, but not automatically get it over a lawyer/sales type.

Yes, finance is important but think of a baseball team (soccer, football, hockey etc). All the players have a different role. When one player becomes too important or powerful the cohesion of the team breaks down. Finance is useful but not so useful that everything else depends on them.

I think your last statement shows your bias! I'd rather have someone trained in the field to do the job than someone who is just very intelligent yet doesn't have the relevant background. Besides, a physicist would, to me, be more valuable than calculating IRR and NPV all day everyday in the back office.

 

[chiro]

I have no idea why finance has become this super-complicated thing that it is.

Finance at it's core is very boring: it's meant to be about resource allocation and management. You have capital and credit and you worry about managing both and creating credit so that you can allocate resources in the best way possible. You have other things like exchange and so on, but the above is still the basic idea of what banking was and should be.

The above is not complicated and finance should never ever ever be that way: if it gets to the point where people don't understand it (I mean any average person in the room) then it's a bad idea: a really bad idea.

Constructing products that people don't understand and buying them is absolutely nuts.

The old fashioned idea of going to see the bank manager for a loan and being scrutinized based on your deposits, saving history, and so on was there for a reason: it's simple, easy to understand for both parties, and more importantly: it actually worked in a lot of cases.

Finance should be boring because it is meant to be boring: it's not meant to be this super creative thing that blows up the economy when the so called "creative products" reek havoc.

If you need super-computers and sophisticated algorithms to do finance, then that tells me something is very very wrong and I'm not saying this because I'm a technophobe (I used to be a programmer). I'm saying this because something like finance was meant to be boring for a very good reason.

 

[intelwanderer]

I have no idea why finance has become this super-complicated thing that it is.

Finance at it's core is very boring: it's meant to be about resource allocation and management. You have capital and credit and you worry about managing both and creating credit so that you can allocate resources in the best way possible. You have other things like exchange and so on, but the above is still the basic idea of what banking was and should be.

The above is not complicated and finance should never ever ever be that way: if it gets to the point where people don't understand it (I mean any average person in the room) then it's a bad idea: a really bad idea.

Constructing products that people understand and buying them is absolutely nuts.

The old fashioned idea of going to see the bank manager for a loan and being scrutinized based on your deposits, saving history, and so on was there for a reason: it's simple, easy to understand for both parties, and more importantly: it actually worked in a lot of cases.

Finance should be boring because it is meant to be boring: it's not meant to be this super creative thing that blows up the economy when the so called "creative products" reek havoc.

If you need super-computers and sophisticated algorithms to do finance, then that tells me something is very very wrong and I'm not saying this because I'm a technophobe (I used to be a programmer). I'm saying this because something like finance was meant to be boring for a very good reason.

Maybe that's why they are paid so much, to make up for that. And why postdocs, etc, are paid so little. Granted, research can be pretty boring too, but...

Shows the priority system here, which I think is rather screwed up. I'm worried whether focusing on stuff like finance rather than science is great for the USA in the long term...

I think your last statement shows your bias! I'd rather have someone trained in the field to do the job than someone who is just very intelligent yet doesn't have the relevant background. Besides, a physicist would, to me, be more valuable than calculating IRR and NPV all day everyday in the back office.

I do think that there are better uses for physicists than the ones we have available right now. But if they want to(not just this. Let's say a physicist wants to go into politics or foreign policy/nuclear weapons policy?), no reason they can't learn. Nothing should prevent them from doing so. Of course, whether they are hired over someone with relevant training is a different matter.

 

[mayonaise]

Why?

Because ideally, learning and doing research in physics train a person to think independently and ask important questions. These qualities help maintain a healthy society. It is therefore socially good that we don't starve. It is personally great that I don't starve, because I think I can make a positive contribution to the gene pool.

I'm not disputing the use of finance altogether just the extent to which the industry has grow. A good read about bringing in physicist to Wall Street is Michael Lewis' book Liar's Poker.

Then you should know that what finance looks like, in large part, depends on what regulations look like. Individual physicists turning down finance jobs doesn't change the regulations. You need to persuade the correct people for this.

Not to be mean, but if you don't think bringing goods and services into the economy is a road to wealth then you have no business in business. I'm not sure what goods were produced in the factory but reducing a nation's industrial base is ruinous in the long run. Many innovations come about by laborers in factories inventing more efficient methods of production. I remember an anecdote like this in the Wealth of Nations.

I mean nothing is a sure way to anything.

 

[Locrian]

Besides, a physicist would, to me, be more valuable than calculating IRR and NPV all day everyday in the back office.

Nobody sits around doing that. Computers do that. Financial professionals do things computers don't do well.

I'm glad that you think so highly of physicists though. How many do you employ? Hopefully a lot, because very few other people find them very useful. Most of the economy would rather not hire them, even if they pretend to think they're super smart. And I don't blame them.

Why don't you regale us with some stories of how awesome your highly paid employees with physics backgrounds are? This place gets a little sad from time to time, and we could use a few happy stories.

 

[meanrev]

I have no idea why finance has become this super-complicated thing that it is.

The old fashioned idea of going to see the bank manager for a loan and being scrutinized based on your deposits, saving history, and so on was there for a reason: it's simple, easy to understand for both parties, and more importantly: it actually worked in a lot of cases.

Finance should be boring because it is meant to be boring: it's not meant to be this super creative thing that blows up the economy when the so called "creative products" reek havoc.

If you need super-computers and sophisticated algorithms to do finance, then that tells me something is very very wrong and I'm not saying this because I'm a technophobe (I used to be a programmer). I'm saying this because something like finance was meant to be boring for a very good reason.

Because of our commoner, selfish desires. Now, Llyod Blankfein is just a regular human like all of us. He has 24 hours per day, and he is tasked to manage a company. He is just doing his job. Now, most of his employees are honest people who just want to make money for themselves or their families (I don't think most people go into finance with ambitions of cheating other people's money.) Nope, in fact they are running a harmless operation. Instead, it is our collective desires and the political pressures that we've produced for these desires that have led to this demon of our own design.

For example, how did mortgage-backed securities begin to exist? Because we wanted tax breaks for our home savings and loans industry when it was on the verge of collapse... So we gave it to them in 1981 and saved them for a while. But Wall Street just cluelessly stumbled upon treasure when the industry unloaded their portfolios for tax benefits. It wasn't the lobbying - no amount of lobbying would have made MBS profitable. Contrary to what people would imagine, no one on Wall Street really sought to profit out of our mistakes. Mortgage trading was as popular as the music department at an engineering school, and besides no amount of work would have prepared Wall Street to find such an exploit. Instead, it was a seemingly innocuous political decision that started the MBS bubble.

Why? Because we demanded home ownership as a universal right, and no one saw it them that this wasn't sustainable. And because no one likes high inflation and unemployment rates, so the Fed raised the interest rates in 1979 in a bid to end the stagflation crisis - they succeeded - but the home savings and loans began to die because of this.

Why do we have a Fed, you'd then complain... Well, because we wanted to get out of an economic crisis when it became increasingly obvious by 1913 that no amount of family wealth would have kept the banking industry afloat when people made bank runs in the midst of an economic crisis. This made sense - families wanted to protect their savings. And in fact, the Fed did achieve most part of its founding objective, considering how we've reduced the frequency and amplitude of our economic crises. Now, this doesn't sound convincing since we're in the middle of the deepest recession since the Great Depression, but if you looked at it from the bigger picture and a statistical standpoint, it would become clear that there is no logical basis for such doubt. Moreover, we forget that it has taken only a century for the Fed to make this happen. I find this entirely acceptable - after all, I reserve the same respect towards why the Clay Millennium Problems mostly remain unsolved. And who are we to say that a few mathematical conjectures are any more "socially important" than the welfare of the populace and putting an end to economic crises?

Now, on hindsight you can say, we shouldn't have given those tax breaks, we shouldn't have raised the interest rates in the 1970s-1980s, and we shouldn't have given the Fed its powers. You could say that AIG shouldn't have insured those mortgages. I find such a statement exceedingly naive from a scientific point of view. If it isn't already clear from the example above, our political decisions have an effect of increasing entropy. That's like expecting entropy to reverse itself. Now, unless something drastic like an asteroid impact event takes place to wipe out half of our population, don't expect the changes to be as instantaneous and simple as removing the layers of complexity and creating a short rulebook. Taking any single step above out of the picture might well have pushed our economy past its tipping point, to its collapse.

Finance at it's core is very boring: it's meant to be about resource allocation and management. You have capital and credit and you worry about managing both and creating credit so that you can allocate resources in the best way possible. You have other things like exchange and so on, but the above is still the basic idea of what banking was and should be.

The above is not complicated and finance should never ever ever be that way: if it gets to the point where people don't understand it (I mean any average person in the room) then it's a bad idea: a really bad idea.

Constructing products that people don't understand and buying them is absolutely nuts.

Physics at its core is very boring: it's meant to be about phenomenon and theory. You have observations and hypotheses and you worry about understanding both so that you can model phenomena in the best way possible. You have other things like universities and so on, but the above is still the basic idea of what physics was and should be.

The above is not complicated and physics should never ever be that way: if it gets to the point where people don't understand it (I mean any average person in the room) then it's a bad idea: a really bad idea.

Inventing theories that people don't understand and publishing them is absolutely nuts.

Yes, finance is important but think of a baseball team (soccer, football, hockey etc). All the players have a different role. When one player becomes too important or powerful the cohesion of the team breaks down. Finance is useful but not so useful that everything else depends on them.

I absolutely agree with your premises, but not the conclusion that you have come to. There's a saying: "Vote with your wallet." Cancel your home loans because they generate billions of turnover for finance. Cancel your health and home insurances because insurers pay investment banks a lot of commissions to get their portfolios reinsured. Don't use ATMs or electronic payment methods. Cash in your retirement fund right away. Don't pay tuition to your university. In fact, don't fund programs for child education because much of their assets are managed in hedge funds. Don't fly airlines that buy futures contracts to hedge their losses against the crude oil, because these contracts were created by investment banks or traded on exchanges that pay proprietary trading firms tonnes of money to create liquidity for their products.

The fact that we cannot do without any of these is because the financial industry does indeed generate useful services and products. The claim that they don't is an entirely false. Now, you're going to say, you are not going to throw away your rights to these services simply because the financial industry has become too powerful for you to avoid recourse from your insurances to the pockets of Goldman Sachs. Right. So let's do this instead: have the government buy over and nationalize every service that shouldn't be in the hands of Goldman Sachs, Morgan Stanley and the likes.

Let's give the governments the power to be direct market makers. Let them create the market for treasuries directly - so instead of having a dozen over banks buy the entire stash of US treasuries so that they can resell to smaller buyers, let's pay our taxpayer monies to a whole new department of the government that now has to be hired to make money for the very products that they have created themselves. Or let's give China the right to be a main market maker for US treasury notes. Or let's give Google the chance to invent an algorithm or sole discretion for finding people to fund the national budget.

It will probably work if we tried - I'm evoking a tone of sarcasm not because I don't think it will work, but because I think no one is going to accept such a solution.

So nope, let's also fix how the government works, let's find politicians that can make it all happen. That has to be easy as well right? No - you have to do the dirty work yourself - politics is in need of people with such forward-thinking ideals for the financial industry.

This boils back to my point is that the criticisms of and proposed replacements for the financial industry in this thread are mostly naive, undue and unfounded.

I am probably being naive but I don't understand why students studying physics (or any science for that matter) would choose a field as socially useless as finance. I once had a "superior" tell me he laid off an entire factory (500+) of people to save a few percentage points on a balance sheet for the owner. The man was worked in corporate finance so I believe that is different from the kind of work two-fish quant does, i.e. high finance, the kind many on this forum seem to aspire to.

This sounds to me like management or management consulting instead.

Instead of channeling your prodigious mental capabilities towards financial work, why not try and develop something useful for the economy and for society? A sure road to wealth is to create productive goods and services that people desire. I know this is easier said than done and indeed, you may fail. However, failure is a risk in any enterprise. I'd rather fail at establishing a business or shooting for tenure than failing at being some financial whiz. This is the way I felt after earning my bachelor's degree in economics.
Two reasons I can think of. First, it is socially useful for me or any other physics grad to not perish in the tenure pursuit.
Why?

A majority of "products" that have been created by the financial industry arise because of our aversion towards risk, much like insurance. If you feel that there's something wrong with the statement, "Insurance should not exist," then there is also something wrong with its semantically-sugar-coated version of, "Exotic options should not exist." Farmers need to protect their crops against disaster. Home insurers need to insure themselves against a huge event like Hurricane Katrina that would drive them - and the beneficiaries of these insurance policies - to bankruptcies, which should then spark a chain of catastrophic results (a cascade of homeless and unemployed people). A semiconductor manufacturer needs to protect itself against volatility in silver and copper prices. A university's endowment fund needs some consistent, but low-risk growth. Most of the trades made in the financial industry are done in good nature. Many of these products were created simply because we found a fair and neater way to create them out of cash and the underlying, just as we have found a recipe for a delicious dish. (Of course, chefs are paid extra over the ingredients for making the food, as a market maker is paid a commission for creating such a combination). It's supposed to be a good thing. The aggressive risk-taking, rogue and inside trading that fit well in headline narratives constitute the exception, not the norm, of the financial industry.

Besides, a physicist would, to me, be more valuable than calculating IRR and NPV all day everyday in the back office.

There is much grunt work whether in finance or physics. There are some elegant elements to finance. For one, an abundance of open problems to work on (not necessarily problems of the profiteering kind). For another, there is abundant supply of quantifiable data (typically price time series) for your models. There's less to worry about proper data collection than actual modeling work. Besides, it's human nature to feel a stronger sense of appreciation for your work when you've been paid more for it. In every other field I know of, the question is whether a balance of your personality and desire for money can be met by a particular job - not, in the other way around, whether you meet the requirements of "passion" for a particular job.

A good read about bringing in physicist to Wall Street is Michael Lewis' book Liar's Poker.

I've read Liar's Poker. I think it's a terrible read for this purpose as compared to something like "My Life as a Quant" by Derman.

There is a lack of jobs in physics; there is a recession going on for everyone. I think it is inanely obstinate to shackle ourselves to the dated view that a move from physics to finance is a passionless behavior of penny-pinching. Instead of driving away the scions of our community simply because they have chosen a career in finance, we should support and assist their decisions to do so. If anything, the physics community needs this alliance now more than ever, and easing the demand for tenure positions is probably a good thing for our future generation of physicists.

 

[SolomonX]

Because ideally, learning and doing research in physics train a person to think independently and ask important questions. These qualities help maintain a healthy society. It is therefore socially good that we don't starve. It is personally great that I don't starve, because I think I can make a positive contribution to the gene pool.

Thinking independently and asking important questions is not a result of being trained in physics. Sure, a physics or any STEM degree helps a person to think analytically and tackle an important problem from many different angles. These are very important skills but they are not solely acquired within the domain of physics. I think these abilities are somewhat natural, but can be sharpened by a rigorous degree program.

Can you provide any good reasons why you should not starve other than your physics degree? What exactly is so special about your gene pool?

 

[SolomonX]

Nobody sits around doing that. Computers do that. Financial professionals do things computers don't do well.

Computers do that, eh? No input required? No analysis of the output? When did computers become sentient?

I'm glad that you think so highly of physicists though. How many do you employ? Hopefully a lot, because very few other people find them very useful. Most of the economy would rather not hire them, even if they pretend to think they're super smart. And I don't blame them.

Training in a rigorous field, such as physics, is of high value to the economy. Many innovations of the past 70 years have come about as a result of a interdisciplinary team of law-makers, businesspeople, and scientists (including physicists) innovating products that have lead to the remarkable world we live in today. Advancement can only continue if we channel our resources into productive fields (communications, infrastructure, health care, etc.) Financing is useful tool in this equation but only if confined within its proper bounds.

I agree fully with what chiro noted earlier, that is, that finance should be very boring and vanilla. If you couldn't explain it to your grandmother then something must be fundamentally wrong with whatever it is you are trying to do.

And of course, as an American and someone who believes in free mobility of labor, if a physicists wants to go into finance, go right ahead. Especially if you can't find work within your field and need money. Of course, understand that finance is not physics and the subject matter should be treated differently. I read a few economics research articles when writing my thesis about applying a gravity model used in a financial model and thought that this is madness!

 

[chiro]

Because of our commoner, selfish desires. Now, Llyod Blankfein is just a regular human like all of us. He has 24 hours per day, and he is tasked to manage a company. He is just doing his job. Now, most of his employees are honest people who just want to make money for themselves or their families (I don't think most people go into finance with ambitions of cheating other people's money.) Nope, in fact they are running a harmless operation. Instead, it is our collective desires and the political pressures that we've produced for these desires that have led to this demon of our own design.

What a load of BS: it's not a harmless operation when you have an industry with huge systemic risk that needs money to not become insolvent all because some people made a bad call.

People thought that LTCM were the smartest guys in finance, and people thought Enron were the smartest guys in the room: neither of them were.

Huge amounts were just completely wiped out completely. Evidence has come out that the people who made these products called them crap. Some of these banks even took out insurance policies betting against the very products that were selling to clients.

Just doing his job? What a crock. The nazi's were "just doing their jobs" as well.

For example, how did mortgage-backed securities begin to exist? Because we wanted tax breaks for our home savings and loans industry when it was on the verge of collapse... So we gave it to them in 1981 and saved them for a while. But Wall Street just cluelessly stumbled upon treasure when the industry unloaded their portfolios for tax benefits. It wasn't the lobbying - no amount of lobbying would have made MBS profitable. Contrary to what people would imagine, no one on Wall Street really sought to profit out of our mistakes. Mortgage trading was as popular as the music department at an engineering school, and besides no amount of work would have prepared Wall Street to find such an exploit. Instead, it was a seemingly innocuous political decision that started the MBS bubble.

Again, the idea of what banking was and should be about was that giving credit to someone was not easy.

There were no subsidies and the only way to get easy credit was if you were a solid government or an oil company.

These easy loans where you had no income no assets helped create the mess.

This is really really simple: banks have been doing this kind of thing for a long time (it's what they are meant to be good at) but they threw it all out the window when they gave people loans that could not possibly pay them back.

Again: this is why banking should be boring and why it's important to just stick to the time tested basics.

Why? Because we demanded home ownership as a universal right, and no one saw it them that this wasn't sustainable. And because no one likes high inflation and unemployment rates, so the Fed raised the interest rates in 1979 in a bid to end the stagflation crisis - they succeeded - but the home savings and loans began to die because of this.

The point of a good bank is to say "no" when they should say no, not because it's politically correct or fashionable.

Again it used to be that when you went to a bank for a loan, they would deny you if they didn't feel you had a good chance of giving them a return on their investment. It wasn't a sure thing, but experience tends to help in this regard (i.e. the bank's experience).

Access to unlimited credit when it's clearly not deserved is not a right of any kind and that's the lesson and the whole point of why banking should be boring.

Bankers of all people who are decent and have a brain cell or two should be the first to realize what happens when you give out easy credit: if they have been in the process of funding businesses or mortgage holders then the experience should tell them what happens when you have an environment that is highly subsidized and where credit is given easily and how that affects the market as well the environment for debt.

Why do we have a Fed, you'd then complain... Well, because we wanted to get out of an economic crisis when it became increasingly obvious by 1913 that no amount of family wealth would have kept the banking industry afloat when people made bank runs in the midst of an economic crisis. This made sense - families wanted to protect their savings. And in fact, the Fed did achieve most part of its founding objective, considering how we've reduced the frequency and amplitude of our economic crises. Now, this doesn't sound convincing since we're in the middle of the deepest recession since the Great Depression, but if you looked at it from the bigger picture and a statistical standpoint, it would become clear that there is no logical basis for such doubt. Moreover, we forget that it has taken only a century for the Fed to make this happen. I find this entirely acceptable - after all, I reserve the same respect towards why the Clay Millennium Problems mostly remain unsolved. And who are we to say that a few mathematical conjectures are any more "socially important" than the welfare of the populace and putting an end to economic crises?

The amount of money sloshing around is at an insane level. The first trillion dollars took a very long time to print (and create on a computer since most money in circulation is purely digital) and from that point money has been entering the system at a frightening rate.

Also we have derivatives that are "valued" at many many times the global GDP. This is very dangerous especially if something happens where these products result in a wiping out of value in the same way that happened with the MBS products.

The other thing that is different is the leverage: the so called market cap of a bank is not what it's assets are. A lot of banks are leveraged up to levels like 50:1 and sometimes a lot higher.

A 50:1 leverage means that a 2% price swing can make it completely insolvent. We didn't have situations like this in the 1930's and it means that we have a situation much more fragile and much more frightening.

You talk about bank runs: you might want to find out how many banks have failed around the time of the GFC: the idea of the FED somehow preventing this kind of thing is really naive.

You might want to look also at how the capital requirements of banks have changed throughout the years too.

Also this idea of reducing the crisis is naive I don't know where to begin. Did you forget the Savings and Loans scandal? What about the MF Global scandal where segregated funds were reached into? If you don't understand the MF Global situation, think of it as if you went to the ATM and your deposit account was empty: that's what literally happened.

Now, on hindsight you can say, we shouldn't have given those tax breaks, we shouldn't have raised the interest rates in the 1970s-1980s, and we shouldn't have given the Fed its powers. You could say that AIG shouldn't have insured those mortgages. I find such a statement exceedingly naive from a scientific point of view. If it isn't already clear from the example above, our political decisions have an effect of increasing entropy. That's like expecting entropy to reverse itself. Now, unless something drastic like an asteroid impact event takes place to wipe out half of our population, don't expect the changes to be as instantaneous and simple as removing the layers of complexity and creating a short rulebook. Taking any single step above out of the picture might well have pushed our economy past its tipping point, to its collapse.

Buddy: this is not a physics experiment, this is finance and it affects everybody.

If credit wasn't easy to get across the board, whether it's for a working family to have a home, a small business, a large corporation or even a bank, then a lot of these problems would be averted.

The other thing is that this situation is not like the one where you have one or two loans that default: this is a global practice and you had a global instance of defaults and subsequently a systemic collapse.

The other thing is that right now, interest rates are near zero.

This means that people can borrow money really really cheaply. It also means that the deposits that are used to create the new money don't get a return on the investment.

This encourages depositors to spend and borrow instead of save.

This whole thing is a bomb just waiting to cause chaos.

I'm not saying you have a simple rule book. Decision makers don't use rule-books because they can't cover all the circumstances especially in a dynamic environment, but they do use guidelines in many cases. I have proposed a guideline that has been used time and time again and it's easy to understand.

When people don't understand what they are buying: they shouldn't buy it. When people are selling something they don't understand, or know beforehand that they really should not be selling something, then they shouldn't sell it.

There are some really basic laws that businesses have to follow that incorporate the above and some of them are related to what is known as fraud.

This experiment called our current financial system is a failure, and at the very least, going back to the era where credit was not only hard to get but hard to create should be a key issue on all relevant policy makers mind.

You can do the above in many ways including with central banks or without central banks, but never the less it's important to do for society at large.

 

[twofish-quant]

I have no idea why finance has become this super-complicated thing that it is.

You have one banana that is worth $1. How much are two bananas worth? The answer is roughly $2. If the price is significantly more or significantly less than $2, you can make a great deal of money, buying/selling one banana and two bananas.

Now let's apply this "banana-rule" to stocks. You end up with a partial differential equation. Now let's add interest rates, foreign exchange, and collateral to it. You end up with very, very complicated partial differential equations.

The above is not complicated and finance should never ever ever be that way: if it gets to the point where people don't understand it (I mean any average person in the room) then it's a bad idea: a really bad idea.

The trouble is that reality is very complicated.

The old fashioned idea of going to see the bank manager for a loan and being scrutinized based on your deposits, saving history, and so on was there for a reason: it's simple, easy to understand for both parties, and more importantly: it actually worked in a lot of cases.

Finance was never that simple. It gets more complicated now, because the trouble is that the money for that loan comes from some person in Dubai, and connecting the dots get messy because of the "banana rule."

If you need super-computers and sophisticated algorithms to do finance, then that tells me something is very very wrong and I'm not saying this because I'm a technophobe (I used to be a programmer). I'm saying this because something like finance was meant to be boring for a very good reason.

One loan you can handle without supercomputers. Five million loans, you need some very, very powerful computers.

And it's not just loans. Think about every financial transaction that you do. Most of that is electronic now, and you end up with massive computer issues.

Even *without* the computational issues. Just think of the database issues. Every line in your credit card or transaction in your checking account has to get tracked, and you end up with horrendous computer science issues.

Then take that for each person and apply things like the banana rule and things get very complicated.

 

[chiro]

You have one banana that is worth $1. How much are two bananas worth? The answer is roughly $2. If the price is significantly more or significantly less than $2, you can make a great deal of money, buying/selling one banana and two bananas.

This is exactly what I don't get.

The last item is really the clincher and it is basically "speculation".

You have hedging and then you have speculation. Proper hedging I agree can help economies, but the speculative BS that goes on that is not true "hedging" is not only un-necessary but detrimental.

The idea of buying something at one price and selling at a slightly higher price is really a worrying thing to me, and this kind of mentality is causing a lot of problems.

People may say "well hedge funds gamble with their own money, so they take the risk", but the truth is that it's not just people that are separated from commercial banking anymore that are doing this.

The point of exchange mechanisms is to facilitate the actual exchange itself not to turn the whole thing into a roulette wheel and a craps table.

Insurance has its place, but gambling doesn't and although the two may appear to be "the same", they shouldn't be.

Now let's apply this "banana-rule" to stocks. You end up with a partial differential equation. Now let's add interest rates, foreign exchange, and collateral to it. You end up with very, very complicated partial differential equations.

Again, the issue is with this mentality of gambling.

I am familiar with some of the basic issues regarding using simple PDE's for this kind of thing but again, this mentality of adding this extra incentive is what gets me.

Things are becoming way more complicated than they ought to be. The idea of buying a stock was simply to put up investment money because people thought that the corporation would make profits that would be shared in.

We have absolutely ridiculous liquidity now with computers especially when the computers make their own trades. For things like an instant buy/sell (wash trades) I would love to see any kind of sane justification for that.

This idea of trying to "control risk" is absolutely ridiculous: again the whole point of finance and banking at its core was never to eliminate risk: The point was to come up with some basic principles of attempting to understand where the risks lie so that the decision reflected more of a "calculated risk" rather than an abolishment of risk.

What I am observing is that people are introducing these instruments and collectively they are tearing things apart.

There is no solid reason why anyone should be interested in the elimination of risk or for the sole intent on profit and to gamble on anything from an interest rate move to a commodity price movement only to make a quick profit.

If people want to buy something, they should not have the liquidity relaxations that allow them to buy and sell at the absolutely ridiculous speeds they do with these computers. If you want to buy something with an option contract then buy it: don't buy it and sell it straight away.

Airlines that buy fuel for real hedging don't wait for the maturity of their contract and then turn around and sell it somewhere else for a quick buck: they buy it because it's core to their business of getting people around the world. They don't need some ridiculous liquidity on the asset to do what a lot of these financial hubs do.

If people want do real hedging then that's fine, but these ridiculous liquidity environments that exist for general transactions are more detrimental than ever.

The trouble is that reality is very complicated.

It doesn't have to be.

Finance was never that simple. It gets more complicated now, because the trouble is that the money for that loan comes from some person in Dubai, and connecting the dots get messy because of the "banana rule."

The way stuff can be packaged is really stupid.

This whole thing of having a "chain" of dependencies is again really stupid.

A contract should have ultimately two parties: in a loan situation you have the party taking on the loan and the party giving it.

This idea of having a "chain" in the lending process is ridiculous: if there are multiple links in the chain, then the person who is loaning at the end should have a direct contract with the person they are loaning from. If the chain is bigger then people should be forced to adopt the loan and terminate a contract with the other link in the chain.

This is just common sense: creating a situation like this is going to blow up when you have all these dependencies everywhere. Again the idea is to keep it simple.

One loan you can handle without supercomputers. Five million loans, you need some very, very powerful computers.

And it's not just loans. Think about every financial transaction that you do. Most of that is electronic now, and you end up with massive computer issues.

I should have stated that the complexity was not to do with the computational power only but also in reference to the techniques used.

Of course an infrastructure to do transactions when billions of them are going on all the time requires the appropriate computational, communications, and secure architecture to facilitate this.

But this is not the same as having some complicated numerical simulation or using algorithms to crawl the web or to use these things to execute trades so that a bit of volatility can be created.

I need to emphasize again that the main issue I have is not with the bread and butter stuff like loans: it's with speculation but not real hedging.

Even *without* the computational issues. Just think of the database issues. Every line in your credit card or transaction in your checking account has to get tracked, and you end up with horrendous computer science issues.

My issue is not with the computational power alone per se: it's more to do with the idea of how risk is handled (but more importantly introduced) and what the incentives are with regard to how that ends up motivating business policies for certain financial institutions.

Finance has become a major part of an economy and that is ridiculous: again the point of finance was to facilitate the things that aided real economies: not to be a major part of an actual economy.

Then take that for each person and apply things like the banana rule and things get very complicated.

It really boils down to that speculative element and what the incentives have done to affect finance and the economy.

It used to be that if people wanted to buy a banana from the fruit shop, they bought it to eat it. They didn't buy it so they could create a so called profit.

This is what banks do: it serves absolutely no use socially. Most people that go to the supermarket to buy food buy it because they are buying the very thing they need. They aren't buying it so they can sell it somewhere else and make a few cents profit, but this is entirely what is happening today.

Speculation has no use and is detrimental to the economy. Not only that, these idiots using policies of near zero per cent are encouraging this.

It's always the same story throughout history: some one gets control of something and manipulates without giving a stuff about how it affects other people.

This manipulation in prices affects prices in a way that the price is way higher than it should be. There is no reason for this other than for banks to make profits.